The Value of Free in GDP

Did the rise of free information technology improve GDP? It is commonly assumed that it did.

After all, the Internet has changed the way we work, play, and shop. Smartphones and free apps are ubiquitous. Many forms of advertising moved online quite a while ago and support gazillions of “free” services. Free apps changed leisure long ago—just ask any teenager or any parent of a teenager. Shouldn’t that add up to a lot?

Think again. The creation of the modern system of GDP economic accounting was among the greatest economic inventions of the 20th century. Initially created in the US and Britain, this system has been improved for decades, and, for all intents and purposes, it is the system in every modern government around the world today.

Although this system contains some flexibility, it also has its rigidities, especially when it comes to free services. I expect the answer to sit awkwardly with most readers. Nonetheless, a little disciplined thinking yields a few insights about the modern experience, and that is worth the effort.

Research

The millennial generation sometimes likes to adopt the attitude that they invented everything except sex (and, sure, some do try to take credit for that). As it turns out, that attitude will not go far when it comes to economic accounting for free services, where nothing is new under the sun. Television and newspapers faced similar issues decades ago.

That is bad news, sorry to say. Prior experience does not provide much reason for optimism. It has always been known that GDP accounting does not handle free services easily, and for one basic reason. If a service lacks a price, then there is no standard way to estimate its worth in plain dollars and cents. Something that has no price also produces no revenue and, by definition, contributes nothing to GDP.

This was an obvious problem when commercial television first spread using advertising as its primary revenue source. The consumption is free, and the only revenue comes from advertising. When the TV experience improved— say, as it moved from black and white to color—GDP recorded only the revenue for television sets and advertising, not the user experience.

There was hope that industry specialists would find some underlying proportional relationship between consumption of services and advertising revenue—for example, between the time watching TV and the value of watching commercials. Such proportionality would have been very handy for economic accounting, because it would yield an easy proxy for improvement in the quality of services. Accountants would merely have to examine improvement in advertising revenue.

Alas, no such relationship could be found. Just look at the history of television to understand why. Television has gotten much better over the last few decades, but—for many reasons—total advertising has not grown. The economics is just not that simple.

A similar problem has arisen today. Search engines attract users, and that generates tens of billions of dollars of revenue from advertisers, and that revenue contributes to GDP. However, the services delivered by search contribute no revenue and, by definition, contribute nothing to GDP. With so many free services today, this weakness in GDP accounting seems awkward. It does not matter how amazing the services are, nor how much they have improved over time. Any improvement in the quality of search services is not a contribution in GDP except insofar as it generates more advertising dollars.

Recently, three professional economists— Leonard Nakamura, Jon Samuels, and Rachel Soloveichik—tried to wade into this topic again, and tried something experimental and novel. They wondered how GDP would change if these free services were reconceived as a barter. (For more details, read their study, “Valuing Free Media in GDP: An Experimental Approach.”  And just to be clear, I did not coordinate this column with them. This column reflects my views of their research, and may or may not reflect their opinion.)

Think of it this way: Google Maps would be counted as output if used by a household to plan a vacation. It could be used as a business input, too, if used by a logistics company to plan deliveries. The study then asks: are we missing a big part of GDP by not counting the recent growth in online free services as a barter?

A Barter Approach

These three economists imagined the following thought experiment: what if the user is “paid” for watching advertising?

This is a production-oriented conception for accounting of economic activity. Every input counts insofar as it helps a user produce something they consume or it helps a business produce output. It is also a conceptual straight jacket as a way to account for value, and that is the point of the exercise. It imposes discipline and consistency on the accounting and makes free services just like every other input in production.

To be clear, this method does not provide any conceptual shortcut to deal with businesses that aspire to be ubiquitous and promote free services to achieve that aspiration. In this conceptualization, such businesses are thought to have given away valuable inputs in order to gain revenue later. So, the giveaway accrues as intangible capital investments, which the economy eventually monetizes as output. (If you are curious, the economists have a long discussion about it, which I will skip for the sake of brevity.)

Applying these ideas took effort and care. The authors had to examine distinct parts of the economy in which advertising supports free services, including print newspapers and magazines, broadcast television and radio, cable and other non-broadcast media, and online media.

The bottom line is straightforward to state, albeit disappointing and surprising: GDP does not change very much. The authors find that between 1929 and 1998, their new measure of real GDP falls by a tiny percentage, and measured productivity growth rises by a tiny amount. Between 1998 and 2012, real GDP rises by a tiny percentage, and measured productivity rises by a tiny amount.

Figure 1 provides intuition for this answer. The figure shows total advertising revenues in the US economy, broken apart by sector. The four sectors have different experiences. Since the mid-1950s, broadcast radio and television ad revenue has risen and fallen, with cable television ad revenue rising enough to generate net growth in the combined total. Advertising online appeared in the late 90s and has grown ever since.

Only one form of advertising has experienced long-term declines, and that was advertising for print newspapers and magazines. It is obvious what has happened: Broadcast radio and television took some of the advertising, and then cable television took another bite, and then the Internet came along and took another chunk. Just as interesting, all this reallocation took place in the face of a near-constant level of total advertising across the entire economy.

That explains what is going on. Since the key input (advertising) did not grow much, there is simply no way a bartered approach (to account for advertising) can make much of an impact on overall GDP growth. The input is merely reallocated between sectors.

Let me rephrase by focusing on the non-Internet economy. Many fundamental economic facts are just what they always have been, free Internet or not. Ride sharing apps made Manhattan more livable, but an auto purchase still costs the average household a high fraction of yearly income. Online sites track your health, but that did not change the need to eat fruits and vegetables. Weather apps let you track the weather, but you still must buy gloves and warm clothing in the winter. In short, the economic production that supports humanity has not changed much.

 

Here is my two cents: these three researchers may have just put the nail in the coffin of using production-side measures of the free economy—and that is not really all that bad. GDP is a measure of total production. It was ever meant to be a measure of how well-off society has become.

More to the point, maybe it is time to focus on the demand-side measures of free goods. In other words, you get a lot more for your Internet subscription, but nothing in GDP reflects that. For example, the price index for Internet services should reflect qualitative improvement in user experiences, and needs to improve.

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